China’s outlook: sunshine and showers

How hard will China’s landing be? Premier Li Keqiang last week set the country its lowest GDP growth target since 1990, of 7pc. Sky News economics editor Ed Conway warns that “some China-watchers are talking about the beginning of the end of the Communist regime”, which will not be able to cope with the social cost of slowing growth. This looks like wishful thinking rather than sound analysis. Many economic data do paint a picture almost as gloomy as China’s urban air haze — but there are shafts of light, too.

Producer prices are deflating rapidly and this is discouraging investment. Private investment in infrastructure, sometimes called fixed assets, fell by 3.4 percentage points in January-February and by 1.8 percentage points overall. Real estate investment growth is half what it was a year ago. This will hit China’s middle classes hard. Many regarded homes and offices as a sure-fire investment, but house prices fell for a fifth month running in February. Last month’s rise in consumer prices probably reflects spending over the lunar new year holidays, which were in February this year as opposed to January in 2014.

Yet it is not all bad. Manufacturing output rose in the first two months of the year, requiring more trucks to ferry goods around the country. Net exports of diesel, the workhorse fuel of China’s manufacturing base, have fallen to a 31-month low of less than 10,000 b/d. In January a year ago, they were 70,000 b/d. Fewer diesel cargoes left China to be sold on the Singapore spot market or shipped to Sri Lanka and Vietnam in January this year than at any time since September 2013, while imports were their lowest since June 2012. Diesel prices have risen. And Chinese oil companies say they are heading back into the black, after a dire fourth quarter.

The PMI, a forward gauge of manufacturing activity, rose in February close to the 50pc inflection point separating expansion from contraction. But the latest PMI index paints a picture of pervasive pessimistic sentiment. Companies in China, it seems, fear the worst. While components such as imports and new orders were up, the “business activities expectation index” was lower by over 7.5pc.

Partly, this is to be expected from the inflation — read “deflation” — data. It almost certainly also reflects a widespread awareness that the motor of China’s economy is not firing on all cylinders. There are still major impediments in the way of its private sector. These allow large, state-owned companies, which dominate key markets such as energy, to flourish. The PMI for large firms is a hearty 50.4pc, while that for smaller, usually private-sector ones, is just 48.1pc.

Crucially, borrowing costs are far higher for private-sector companies than for state-controlled ones, known as yangqi. This is driving private-sector trading companies out of business. A major government investigation into tax fraud is targeting private-sector refiners and gasoline blending companies. In many ways, the taxes these firms are evading are ones that criminalise private-sector activity — only state-run firms may import crude, gasoline or diesel. This gives state-run firms a major cost advantage over potentially more-efficient private-sector rivals, but also pushes up China’s energy costs. Regulated transport fuel costs are far higher in China’s Fujian province than Taipei, across the Taiwan strait, and this encourages fuel smuggling.

Businesses and the government know that it will be impossible to win the battle against economic slowdown with one hand tied behind their back. Li called for “structural reform” of the energy sector in his address to China’s tame parliament, the National People’s Congress, last week. There are signs that this is starting to happen already. More teakettle refiners are to be allowed access to crude imports. Beijing may open up imports of road fuels to private firms. And, according to the NBS, private-sector Chinese firms ploughed $130mn into upstream oil and gas in January-February, almost 30pc up on the year.

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